Definition
The term revenue break-even point describes a calculation analysts can use to determine the level of revenues at which a company remains profitable. The higher a company's actual revenues are above their break-even point, the higher is their potential profitability.
Calculation
Revenue Break-Even Point = Operating Expenses / Gross Margin
This ratio can also be determined on a cash flow basis, which removes all non-cash expenses such as depreciation and amortization.
Revenue Break-Even Point = (Operating Expenses - (Depreciation + Amortization + Other Non-Cash Expenses)) / Gross Margin
Explanation
Also known as the sales break-even point, the revenue break-even point provides the investor-analyst with insights into the profitability of a company. The ratio can be used to estimate the increase in profits that result from a potential acquisition.
The company's management team can also use this measure to understand the maximum amount of profits that can be generated when operating at their maximum revenue producing capacity. The measure can model profits when faced with the option of expanding the revenue producing capacity of the business.
Since production cost can vary over time, analysts as well as the company's management team should track this measure over a number of reporting periods. This will smooth out any short-term irregularities in the reporting of operating data.
Example
Company A has excess capacity at one of their production facilities and the company's management team has been asked to model the potential impact to profits if the company were to sign a contract with Company XYZ that would consume the remaining capacity at that plant. Company A's current revenues are $7.25 million, with operating expenses of $2.125 million and a 35% gross margin. The table below shows the company's break-even point before signing the contract with Company XYZ.
| Break-Even Analysis (000s) | |
| Current Revenues | $7,250 |
| Operating Expenses | $2,125 |
| Gross Margin | 35% |
| Break-Even Point | $6,071 |
| Maximum Profit Potential | $413 |
Note: The maximum profit potential is derived by subtracting the break-even point from current revenues and dividing that value by the gross margin percentage.
The table below shows the company's break-even point after signing the contract with Company XYZ.
| Break-Even Analysis (000s) | |
| Current Revenues | $9,000 |
| Operating Expenses | $2,638 |
| Gross Margin | 35% |
| Break Even Point | $7,537 |
| Maximum Profit Potential | $512 |
As the above table demonstrates, Company A could realize nearly $100,000 in profits by signing the contract with Company XYZ.
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